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What State Bank of Pakistan is required to do with emergence of new financial Year 2020?


Muhammad Arif

Muhammad Arif
Muhammad Arif: Chairman Centre of Advisory Services for Islamic Banking and Finance (CAIF), Former Head of FSCD SBP, Former Head of Research ArifHabib Investments and Member IFSB Task Force for development of Islamic Money Market, Former Member of Access to Justice Fund Supreme Court of Pakistan.

Now Baqar Reza has taken charge of new Governor of SBP and has given a lecture to the press on his Monterey policy philosophy but actually people don’t understand these briefings and they remain more interested in results that impact their life.

Governor, State Bank of Pakistan (SBP), Dr. Reza Baqir has assured that the country has come out of the economic crises as it has achieved economic stability including financial one, which has created investors’ confidence that is very positive signal. Dr Reza said the present government had assigned two major tasks to its economic team that is, bringing economic stability and ensuring inclusive economic growth in the country; where there is improvement in the life of the common man.“The two main reasons for the economic instability were: external deficit and fiscal deficit. Now, these are being addressed effectively and incredible manner. The external/trade deficit situation is improving. He added that Government would borrow from the money market and not from the SBP. This would save State Bank of Pakistan from printing new notes which push inflation. About the exchange rate, SBP Governor said a fixed rate or free float currency policy were not in favor of the country. Rather, SBP had adopted the market-based policy for it. Regarding the key interest rate, Dr. Reza said SBP’s Monetary Policy Committee did take into account the projected inflation before fixing it. “We shall be fighting inflation to our best,” he reassured, adding the interest rate was the best tool to control inflation. He said the state bank had to work for three objectives including financial stability, maintaining exchange rate and for sustained economic growth. The SBP Governor defended the agreement being signed with IMF maintaining that it had sent positive signals to the entire world about financial stability in Pakistan that had also built confidence among the local and foreign investors.

Looking in to Egypt from where the governor has come as IMF representative the inflation of Egypt in 2019 is above 15% and 1 year T-bill yields are at 20%. The currency has depreciated from 2016 i.e. 8.5 Eg pounds per US$ to currently in 2019 as 19 Eg pounds per US dollar. Here we give grace marks to the governor for Egypt economy as it may have deteriorated due to regional environment. But here in Pakistan his experience of Egypt cannot be a good example.

Now in this context we quote another recent example of European Union where it has been proved that extreme monetary policy has an extreme impact on distribution. This is the lesson of the last nine years in the euro zone, in which the ECB has continually loosened monetary policy, to the point of introducing negative interest rates and bond purchase programs running into trillions of euros. This has brought Changes in net interest income in individual economic sectors in various euro zone countries.

Net interest income is the difference between interest income (e.g. on bank deposits) and interest expenses (e.g. for loans). Here we take into account changes in both interest rates and volumes, as sometimes there are large changes in volumes – e.g. due to the sale of bonds or additions to bank deposits, that should be regarded as a conscious reaction to low interest rates.

By  calculating opportunity costs or gains by comparing actual development with a hypothetical “normal“ trend and concentrating on the actual development of net interest income over a period of time the changes in households‘ net interest income are in some cases dramatic. This is particularly evident if we look at the cumulative annual changes compared with the base year of 2008, when the easing of monetary policy began.

The differences range from +17% to -12% of the respective gross domestic product. The major losers include households in Italy, Belgium, Austria and Germany. This is due to a drastic reduction in the bond portfolio from around EUR 800 billion (end of 2008) to EUR 290 billion (end of 2017), which led to a dramatic decline in interest income. Austrian and German households also particularly suffered as a result of a slump in interest income, which fell by about four-fifths in both countries during the period under review – even though the associated assets grew by around one quarter.

Finally, in the case of Belgium it was primarily a (slight) rise in interest expenses on debts that was responsible for the decline in net interest income. This development against the trend is attributable to rising debt and a very slow reduction in interest rates on loans. The main interest rate winners, on the other hand, include households in Portugal, Spain and Finland. In the two “southern countries“, changes in volumes have boosted interest rate movements. A sharp rise in deposits has curbed the decline in interest income, while a reduction in borrowing has accelerated the fall in interest expenses. In Portugal, this combination of rising assets and falling liabilities actually caused negative net interest income to become positive.

Meanwhile, Finland benefited in particular from a sharp drop in loan interest, with debts at a high level and increasing further. However, interest rate gains and losses of households do not tell the full story of interest rates. Net interest income of other sectors – companies, financial service providers and states – has also changed significantly in recent years.

This is the same case with USA, China and India where inflation has inched up with surge in GDP growth in USA and plunge in GDP growth rate in India and China. So mixed reactions are coming in different countries.

In nut shell it gives a lesson that each country has its own ground realities so they are required to pursue fiscal and monetary policies according to country own environment, conditions of its people and rules regulations prevailing in that country.

Now at this point we come to point we come to Pakistan.

In Pakistan by changing policy rate and/or changes in certain liquidity ratios, State Bank of Pakistan influences cost and/or availability of money and credit in the country to achieve inflation target without being prejudice to real economic growth target. Reserve money basically depending on currency circulation and with banking sector had been used as an operational target. After weakening of broad money growth and inflation relation (as a result of financial sector reforms and restructuring), SBP transferred the operational target to the overnight money market repo rate. Various monetary conditions indicators are used to decide on the direction and magnitude of monetary policy stance. Budget deficit (with its financing mix), money supply (with its composition), local currency prices of imported goods, wheat support price, and expected (higher) inflation play an significant role in generating inflation while real income growth, and (international trade) openness help dampening it.

Inflation in Pakistan has been found equals to rate of broad money growth minus the real output growth which simply shows inflation in Pakistan has mainly been a monetary phenomenon. Monetary policy has provided somewhat stable background for the economy as we saw standard deviations for inflation and broad money growth to be same during 1951‐2010.

However monetary policy, in coordination with the fiscal and other relevant policies, influences the level of aggregate demand in order to achieve noninflationary sustainable growth. The economy can operate at any level of national income and employment (within the production frontier), depending on the state of aggregate demand.

An insufficiency of aggregate demand results in unemployment and an excess demand results in inflation. The overall level of demand includes investment as well as consumption expenditure, both of which depend upon the availability and cost of money and credit in an economy.

SBP uses its policy rate and changes in some liquidity ratios (e.g. cash reserves requirements) to affect the cost and availability of money and credit (and thus the aggregate demand) in the economy to raise the employment by increasing the money supply and making credit relatively cheap and easy to come by. Conversely, when a state of full employment has been reached it will then be necessary to restrain further increases in money and credit (in order to tame inflation); which in the absence of any improvement in productivity, will be the likely result of an excess demand situation.

Internal imbalances in a country are also reflected in external accounts of the economy. Certain aspects of monetary policy also play role to correct external imbalance(s). High policy rates may be necessary at times of worsening of balance of payments, and/or when foreign interest rates are rising; to discourage foreigners to withdraw short term investments and reducing pressure on country’s foreign exchange reserves. It can not only discourage withdrawal of foreign funds but may also attract them and thus help finance a payments deficit and keep it from causing a drop in foreign exchange reserves.   Being central bank of the country, SBP issues its monetary policy statement(s) to announce it measures related to policy and conduct of monetary management in the Pakistan on bimonthly basis.

Now in 2019 Pakistan is moving towards increase in inflation with decline in employment. Officially the unemployment rate of Pakistan in 60% undocumented economy is 6% in 2019. With population of 200 million the age group from 19 years to 60 years is around 50% (including female and male). This counts around 100 million out of this 6% is unemployed making the number as 6 million or 60 lacs. This is a huge number with ongoing increase.

Currently Pakistan’s Current Account deficit has come to 2.0 USD bn in Mar 2019, compared with a deficit of 4.6 USD bn in the previous quarter. But this has occurred with decline in import as well in export. So with these industrial activities are going to go down.

Leaving aside IMF instructions SBP Exchange rate would remain attached with the market movements meaning that it can cross Rs 200 figure. As per academic views of monetary policy this is required for increase in exports. Secondly Government would not borrow from SBP but this is announced each year with no change. Regarding tax government should employ technology i.e. data with NADRA instead of coming with daily announcements that every animal, piece of land, human whether one year old, birds and even air has brought under tax. This all looks futile exercises. Why wizards in MOF have taken away zero tax rating on six exporting industries, nobody knows.

Finally coming back to SBP whether it looks rational that SBP may go with increase in its main rate to counter inflation and downward trend of county growth. No Sir No this is very risky strategy. Behind the curtain it would only depreciate PKR in the coming times and nothing more.

So positive changes can come only when business community, political stakeholders and prominent economists may sit on one table.  Pakistan requires lot of changes through legislation on economic structure with changes in almost every institution. It’s being circulated in media that 80% of PTI cabinet is incompetent and officers sitting in bank and SBP are responsible for bringing depreciation of PKR in interbank market. Whether true or not but from here we have to move cautiously and bring back the status of SBP when it was considered a most honest institution of Pakistan.

Important economic indicators 2014-2019
2014 2015 2016
SBP prime rate 6.50 5.75
Real GDP growth% 4.1 4.1 4.5
Inflation CPI% 8.2 3.2 3.2
Fiscal deficit % of GDP -5.5 -5.3 -4.6
Current account % of GDP -1 -1.3 -1.7
Total Debt and Liabilities % of GDP 78.1 82.4 86.9
Revenue 3.6 3.9 4.4
2017 2018 2019
SBP prime rate 6.50 7.50 12.25
Real GDP growth% 5.4 5.8 2.9
Inflation CPI% 3.9 5.4 9.4
Fiscal deficit % of GDP -5.8 -6.6 7.0
Current account % of GDP -4.1 -5.8 -4.0
Total Debt and Liabilities % of GDP 80.2 86.4 91.2
Revenue (Rs in trillion) 4.9 5.2 3.5 (Jul-March 19)


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